Google Trades at a Market Crash Valuation
Glen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
While it is true that Google (NASDAQ: GOOG) used to be expensive, if you are looking for a company that is worth owning across the next decade, this is the one. They made $8.75/share this last quarter which puts their forward P/E around 17.3 for a company that has consistently had revenue growth of around 27% and Earnings growth around 25%. Not only that, but if you study their cost structure and try to understand how and where they make money, the picture for future growth is intact. Before I get into it, look below and see how Google is less expensive than it used to be.
The Present Valuation
The present valuation of Google prices it to grow at 5.9% if you use the Ben Graham Formula where P/E = 8.5+2G. If you think that they will beat 5.9% growth for the next decade, now is an excellent time to buy because the price is undervalued. I modeled their historical revenues below and found that the growth is strong and highly predictable on a quarterly basis. Also note that the company has $50 billion of cash at present, which is 25% of their market capitalization. If you price google in terms of EV/E, the numbers look even better at below a 15 multiple. This is more or less valuing Google as if it is no better than the rest of your average S&P500 company. I would argue that Google is better than average.
In my historical revenue analysis, below, I noticed that Google's revenues are not only growing (positive), but they are also growing at a highly predictable rate (positive). In theory, you'd think that this would make a case for analysts to easily project price targets based on future discounted cash flows to shareholders. At present, targets range from $750 to $850. That's an equivalent P/E of 21-24, which using the Ben Graham growth formula suggests that analysts think Google will grow at 6-8% on a forward basis. If you think that this is out of line with reality then you'd probably agree with the idea that their price targets are biased by the current price. Statistically if you study analysts, they have a better probability of predicting current stock price than future stock price --- so this is in line with my expectations. It's perfectly normal to see companies trade at extreme discounts to what they are worth for extended periods of time.
The Secret Sauce
Google is driving revenues from an increase in click volumes, which are increasing at 39% YOY. Their costs are increasing as well, but only buy 16% YOY. The latest rumors are about Google joining the party of cloud storage as a service provider via Google Drive. Historically, when Google has a bad quarter, it's usually due to a higher R&D cost which have all been in good judgment in regards to the future opportunities that they have unlocked. Lately though it's been smooth sailing.
Market Crash Valuation Analysis
To me, the most fun part about Google is my market crash analysis. During the market crash, the valuation of Google dropped to $85B. At the time, Google made $4.2B a year. Now they are making $9.7B a year. Their earnings are up 130% in that time. If their market cap held the same ratio to earnings as it did during the crash, the market cap should be around $195B. Note that that is almost exactly where Google is trading, at market crash valuations. But wait! It gets even better! Now they have $50B of cash as opposed to $16B of cash during the market crash. So, once you back out the cash, their valuation at present is even worse than their market crash valuation.
Comparables
Yahoo (NASDAQ: YHOO) presently is running at about 14% of the share of the online search market compared to Google's 66%. Yahoo's valuation of 15x forward earnings is in the ballpark of Google. Is this in line with what you'd expect? Nope? Me either. Meanwhile, Microsoft (NASDAQ: MSFT) handles 15.2% of the share of online searches. Microsoft is a cash cow that I actually think is also undervalued as a majority of their earnings come in as free cash flow and they are trading at around 11x earnings, which is incredibly low. Finally, no analysis of the internet search market would be complete without the infamous Chinese search giant Baidu (NASDAQ: BIDU). It's P/E is actually about where Google's could be, weighing in at 45x earnings. I can't recommend buying Baidu at these prices.
The bottom line
When you have a high growth company trading at market crash prices, as is the case with Google, there is a lot more opportunity for future gains than future losses for those who take a stake today.
bradford86 has no positions in the stocks mentioned above. The Motley Fool owns shares of Google, Microsoft, and Yahoo!. Motley Fool newsletter services recommend Baidu, Google, Microsoft, and Yahoo!. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
